The global economy is entering a more complex phase. Interest rates are no longer anchored near zero. Governments are deploying fiscal policy more actively. Capital investment – in infrastructure, energy security, defence and digital capacity – is rising in strategic importance.

Financial companies sit at the centre of these shifts. They intermediate savings, allocate capital, underwrite risk and facilitate transactions. When the economic regime changes, the transmission mechanism runs directly through the financial system.

After a prolonged period defined by ultra-low interest rates and cautious balance sheet management, the financials sector today is operating in an environment in which capital generation and productivity gains may become more important drivers of returns.

The war in the Middle East is a reminder that this evolving economic backdrop is unlikely to be linear. It has contributed to higher energy prices and increased market volatility, reinforcing the importance of resilient balance sheets and disciplined capital allocation across the financial system.

We are liable to continue to see periods of uncertainty such as this and the impact it has on nearer-term growth and inflation. However, our focus is very much on the longer-term structural drivers, discussed below, that remain intact.

Normalised rates and capital discipline

For much of the previous decade, interest rates in developed markets were exceptionally low. That contributed to compressed margins in parts of the banking system and distorted the pricing of risk across asset classes.

A more normalised interest rate backdrop changes the equation. Banks are better able to earn appropriate spreads on deposits and loans. Insurers can reinvest premiums at more attractive yields. Savers once again receive compensation for capital. Risk is more explicitly priced.

This does not eliminate risk. Higher rates can expose weaker borrowers and create credit stress if growth slows. However, from a structural perspective, the financial system is operating in a more economically rational framework than during the zero-rate era.

At the same time, fiscal policy is becoming more active. Public investment initiatives require financing and private sector capital expenditure is responding to shifting geopolitical and supply chain realities. A well-capitalised and functioning financial system is essential to supporting that activity.

Regulatory recalibration

The financial system is entering this phase from a position of strength. Over the past decade, capital levels have risen materially and supervisory oversight has remained rigorous. Balance sheets are much more conservative and liquidity buffers higher than in previous cycles.

More recently, policymakers in parts of the US and Europe have begun to discuss whether elements of the regulatory framework can be simplified without compromising stability. In the US, proposals under discussion would allow large banks greater flexibility in returning capital to shareholders, supporting loan growth and improving capital efficiency. In Europe, there is growing focus on simplification and consolidation to enhance competitiveness.

This is not a wholesale loosening of safeguards. Rather, it reflects recognition that regulatory regimes can accumulate complexity over time. For investors, improved capital efficiency – if delivered prudently – can support stronger returns on equity while preserving resilience.

A broad and differentiated sector

Financials are the second largest sector within global equity markets and encompass a wide range of business models.

Source: MSCI, 30 January 2026.

Banks are one component, but insurers, exchanges, trading platforms, asset managers and specialist lenders each have distinct earnings drivers. Life insurers benefit from demographic and savings trends. Exchanges and platforms can benefit from elevated market activity. Asset managers are leveraged to flows and equity markets. Emerging market lenders operate in economies where financial penetration continues to deepen.

These subsectors respond differently to interest rates, growth, inflation and volatility. The diversity of drivers within financials allows for differentiated sources of return across the cycle.

In certain regions, particularly Europe, valuations remain at discounts relative to broader equity markets despite improved profitability. While valuation alone is not a catalyst, it can provide a degree of support if earnings remain disciplined and capital allocation rational.

Productivity and technology

Technological advancement is another important structural factor. Artificial intelligence and advanced data analytics are reshaping many industries. Earlier this year, concerns about disruption contributed to volatility across parts of the financial sector.

However, financial services are inherently data-rich and process-intensive. Credit assessment, fraud detection, compliance monitoring and customer servicing are areas where automation can enhance efficiency and accuracy. Several institutions have cited tangible productivity gains and medium-term return targets supported by technology adoption.

External research suggests that banking and insurance are among the sectors most exposed to productivity improvements from AI deployment. For well-capitalised incumbents, scale and data depth can be competitive advantages.

Rather than displacing established institutions, technology may reinforce the operating leverage of those able to implement it effectively.

Capital allocation and income

Financial companies are significant generators of cashflow. When capital buffers are comfortably above regulatory minimums, this can support dividends and, where appropriate, share buybacks.

The Polar Capital Global Financials Trust operates an enhanced dividend policy targeting a 4% annual distribution, paid quarterly. While dividends are not guaranteed and may be reduced in adverse market conditions, capital discipline remains central to our approach.

The Trust invests across the global financials universe, including banks, insurers, payment companies, exchanges and asset managers. Approximately 40% of the portfolio is currently invested in US and European banks, reflecting our view that many of these institutions combine strong balance sheets with improving capital efficiency and exposure to evolving macro conditions.

Active management is essential in a sector shaped by economic cycles, regulatory change and subsector rotation. Within the portfolio, we balance exposure to US banks benefiting from regulatory recalibration, European banks trading at valuation discounts, insurers positioned for long-term savings growth and platforms that can benefit from elevated market activity. This diversified positioning reflects our view that different parts of the sector will lead at different stages of the cycle.

Positioned for the next phase

The defining features of the previous era – ultra-low rates, subdued credit growth and continual regulatory tightening – are evolving. Today our investment world is characterised by stronger balance sheets, normalised interest rates, more active fiscal policy and regulatory recalibration.

Financials will not deliver returns in a straight line. Cyclical setbacks are inevitable, and periods of volatility should be expected. However, the sector’s central role in capital formation – combined with improved resilience, disciplined underwriting and more efficient capital allocation – suggests it is positioned differently for the phase ahead.

The graph below shows that financial companies are becoming more profitable, with their return on equity – a measure of how efficiently companies generate profits – has improved significantly.

Financials delivering stronger returns (%)

Source: Polar Capital, Bloomberg, 31 December 2025. Note: Return on Equity shown for the benchmark; MSCI All Country World Index Financials Index.

For the Trust, this aligns closely with how the portfolio is constructed. We focus on well-capitalised institutions with durable franchises, prudent risk cultures and the ability to generate attractive returns across the cycle. Our exposure to US and European banks reflects our view that capital efficiency and regulatory evolution can support sustainable profitability, while our holdings across insurers, exchanges and asset managers provide differentiated earnings drivers within the broader financial ecosystem.

In our view, the sector today combines three features that rarely coincide: structural resilience, improving capital dynamics and supportive macroeconomic conditions. That does not eliminate risk, but it does create a more constructive foundation than has existed for much of the past decade. The sector’s return on equity has improved materially over recent years, reflecting both stronger balance sheets and more disciplined capital allocation. For long-term investors willing to accept cyclical variability, we believe financials – and active exposure to them through a specialist strategy – offer a compelling opportunity as the economic regime continues to evolve.